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- At least two things loom large now in this public dialogue that goes on.

One is fiscal policy or what Congress will and won't do, and the other is monetary policy, interest rates, the economy, what the Fed may able to do or not do.

I'm Chris William and welcome to the most widely watched and longest running source on Carolina business policy and public affairs, seen each and every week across North and South Carolina for more than 30 years now.

In a moment, there is a certain symmetry in our guest joining us again today.

He was our last guest in the studio before the COVID shutdown, and now one of our first guests back in the studio as we have restarted.

We welcome again the president of the Richmond Fed, Tom Barkin.

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(upbeat music) On this edition of Carolina Business Review, an executive profile featuring Tom Barkin, President and CEO of the Federal Reserve Bank of Richmond.

(upbeat music) - You know, it feels like the general tenor and tone of the overall economy and community activity has slowed to some degree.

And we're glad to have our guest back on the program.

We welcome Federal Reserve President of the Richmond Fed, Tom Barkin.

President Barkin, welcome back to the program.

- Great to be with you Chris, looking forward to it.

- Thank you sir.

And I wanna completely disclose and disclaim, for really you as you watch this program, that the program's being recorded on January 20th, 2023.

And why that's important is because Fed officials have a certain commitment and responsibility about public comments around open and closed periods, around interest rate debates and discussions.

And we are within that window.

But this program may be seen when the window is closed.

So I just wanna fully disclaim that at the top of the program.

President Barkin, you know, everybody's talking about inflation, surprise, surprise.

Inflation is, in my terms, pretty epic at this point.

Do you think that... And it's become also fairly personal and intimate on personal income statements and balance sheets.

Is it going to get worse before it gets better?

Are we closer to the end?

Do people have any idea what really the longer tail is on this?

- Yeah, so many questions there, let me try to hit it.

First of all, it's clear to me that an entire generation has now come back to remembering one simple fact, which is that we hate inflation.

Everybody hates inflation and we hate it 'cause it's unfair.

Your boss gives you a raise.

And then it feels like he's finally recognized you as an individual.

Then you go to the gas pump, and it feels arbitrarily taken away, it's exhausting.

I mean, it's exhausting to deal with a supplier who's trying to raise price.

It's exhausting to spend the additional amount of time you have to spend to shop around to find better prices.

And it creates uncertainty about where to invest, when to invest, when to save, how much to save.

And so I think it's become perfectly clear that everybody hates inflation, first point.

You know, we are the group mandated to do something about inflation.

And so I personally feel very much charged on behalf of the people in this country to go try to do something about inflation.

And obviously, starting at the end of last year, we've been increasing rates, reducing the size of our balance sheet, withdrawing stimulus, in an effort to try to send a message on and do something about inflation.

At the same time, a lot of supply chains that had gotten stretched are getting better.

I'm sure you've had the ports on.

And they'll tell you things are getting better in terms of transportation and the like.

The labor market's starting to ease.

And so some good things are happening.

And if you look at the data, what you'll see is that the inflation peaked three or four months ago.

And the reads from the last several months have been encouraging.

That's what I'll say, they've been encouraging.

I don't wanna...

So I'm hopeful that we're past peak.

We're still not where our target is, or where the American people want us to be, which is prices so stable that it's not a topic of conversation.

- So stable prices and dropping prices are two different things.

So could you ever see a retrenchment of the numbers...

In other words, some of these prices, can they drop as well as going up dramatically?

Or is this a new high watermark?

- Sure, and I mean I think you're seeing prices drop.

I mean, one of the reasons that the last three months have been so encouraging on the inflation side is that there are two or three big items that increased during COVID, used cars, gasoline, that have not only come back to flat, they've come back to down.

And so you'll see gas prices at the pump are nowhere near where they were back in the early summer.

Used car prices escalated hugely during COVID.

They've come down 15 or 20% since.

And so we're definitely seeing those reversions.

I think you have to be careful with 'em, because the median inflation rate is still too high.

The average is coming down, but the median's too high.

And that's 'cause some of these reversions are skewing the average.

And so for me, I'm still looking for the median to come down, so that...

There's always gonna be things that go up in price and things that go down in price.

But the thing in the middle, that most of the stuff you shop for, is still down close to our target of 2% annual growth.

- Is 2% really the long-term meeting?

Is that the target here?

- We've set 2% on a PCE, which is not the CPI.

Right now, I think the PC headline is about five and the core is in the mid fours.

And so we're still about double where we wanna be.

- Is there concern...

I'm sure there's concern, this is is a little bit...

It might sound a little uninformed.

But is there concern that these interest rate increases as the Fed has stated, not just you but your boss, Chairman Powell and others, would, and again, this is my term, sort of break the economy?

- Well, the objective isn't to break the economy.

The objective is to get inflation under control.

And as I started, I think everybody in the economy wants inflation under control.

And if we're not gonna do it, you have to ask who will, right?

And so my objective, our objective, is to get inflation under control.

We're making some good early steps on that.

There's still more to do.

You don't necessarily have to break the economy to do that.

And there's lots of arguments about why you might not.

But I don't think the objective is focus on the economy.

The objective is to focus on inflation.

And that's what we're doing.

Just for some context, I think you remember, I remember the '70s.

what we may not remember is what the Fed did and didn't do in the '70s.

And I think everyone agrees the inflation we had at the end of the '70s is nothing we'd ever wanna go back to.

The Fed at that time, what it would do is it would see high inflation, it would raise rates.

It would see the economy start to weaken, and it would lower rates.

Then inflation would come back even stronger and even higher.

So the fed would have to raise rates even higher.

And then the economy would weaken, and it would lower rates again.

And then inflation would come back even higher and even higher.

And that's how you get to the kinds of stories that you and I tell of our first mortgage when interest rates were 13 or 15 or 17%.

That's how you get there, is by reducing your focus on inflation too soon.

So you know, my focus, and I hope our focus will be, on let's cut the head off the snake of inflation, let's put it to bed once and for all.

There may or may not be some slowdown as a result of it.

But don't focus on the slowdown, focus on inflation.

Because with low inflation, then you've got the underpinnings of an economy that can grow for a generation, as we've done for the last 30 or 40 years.

- Is there some specter of all of the liquidity that's still in the system that could also come to push prices even higher, once the Fed feels like there's some control of inflation?

Can all of that still come back and be spent?

- Well, I think what we're seeing right now, you know, we've raised rates, and when you raise rates, interest-sensitive sectors are hit pretty quickly.

You've seen that in housing.

You've seen that a little bit in automotive.

The dollar's gotten stronger.

And that's that impact on imports and exports.

But a lot of sectors haven't really been affected.

And I think that's because a lot of the pandemic-era money is still in the system.

Specifically, there's well over a trillion dollars in excess savings in people's bank accounts.

And what you see month after month after month, is people are spending down those savings.

Debt reduced significantly during the early stages of the pandemic.

People used their money to pay down their debt.

That's coming back up.

And so debt now is about where it was before the pandemic.

That's been supporting spending.

I'd even add, this isn't money in the pockets, but employers who fought like dogs for 18 months to find workers are pretty reluctant to shed workers until they absolutely have to.

They don't wanna go back there again.

So there's a lot of this pandemic era, I'll call it artificial impact that is still buoying the economy.

And that's part of why it hasn't been as much affected as many people have predicted.

- You talked about the mean of inflation over a longer term.

What is the mean of federal funds rates over a longer term?

- So I read a book over Christmas which was interesting.

And it was "The History of Money" and it basically made the point that over the last 700 years there have only been 20 years where the interest rate was under 3%, and those were the last 20.

And so I don't know where we're gonna end up.

Most of my colleagues would predict that the neutral rate of interest is somewhere between two and three 1/4.

I just gave you 700 years.

Maybe things are different today and maybe they're not.

But I do think we're in an adjustment process as an economy, from one where the interest rate was historically quite low, to one where maybe it's getting back to something closer to normal.

- And maybe split the difference, but which is back to the point.

So we've got, boy, a couple things here, President Barkin, a lot of different ways I want to go with this.

I do wanna get to the unemployment thing because I know that's a crucial debate what goes on within your group.

Is there a sense of those people that participate now in the system, 40 year olds, 50 year olds, 30 year olds, that do have an understanding of history, and some of these rates and inflation and interest rates.

Is there a general sense of a return to historic averages?

Or do you think there's still an expectation that the last 10 or 15 years was normal?

- Well, my kids would be the first to tell me, I don't have the first clue what 30 year olds think.

So I'll try to pontificate on it, but I'm not sure I'm the expert.

I really do think that one of the reasons you have cycles in American business is that it takes a cycle for a new generation to forget, and/or make the same mistakes as the past.

I think we have a recession every eight to 10 years because that's how long it takes a management team to believe that the last management team didn't know what it was doing, and it really does.

I think we have market crashes at some period because traders trade out and lose memory.

And maybe you could even say that about inflation.

That it took 40 or 50 years for us to go back to...

I do think there's some, everyone's gotta experience it for the first time.

And one of the things that I think is clearly going on in the labor market is the COVID recession was not really a labor recession, right?

The last labor recession, which was a big one, was '08 and '09.

And in that period of time, I remember very clearly, my friends losing their jobs, having to sell their houses, whatever happened to them.

But if you're 36 right now, so 15 years after that, that's just not that live of a memory in your experience.

And we'll see, but if we do have a labor market slow down, there will be some more attachment to jobs, willingness to do different things.

All those things are part of people believing that employment can be fragile.

- Yeah, Alphabet, Google, at least during the production, our production date here on this program, just announced a 12,000 reduction in headcount.

Facebook did it before, Microsoft has done it, et cetera, et cetera.

And the tech industry, as you know, has made a lot of cuts.

Do you think that's specific to tech?

Or do you think that's a harbinger of what will come in some industrial sectors?

- So the economy is heterogeneous, as you know, lots of different sectors, lots of different pressures.

If you look at the overall data, the overall data does not look like we're in a recession right now.

We have three and a half percent unemployment, which is the lowest in 53 years.

And it's hard to imagine we're in a recession with that low of an unemployment rate.

That said, if you sell things to low-income consumers, or if you're in the housing sector, right, or you're a deal maker, or you're dependent on digital advertising, it does feel like a recession.

And the way I describe it is this.

I talked about interest-sensitive sectors like housing getting hit, or deal making.

Those got hit by interest rates.

For the rest of the economy, what's happened is everybody's got a recession playbook.

They filed it away after the last recession.

They've pulled it back out, they've updated it.

And I'm talking to many, many companies that are looking at or working on page one of that playbook.

Page one of that playbook is hiring freezes or headcount freezes, page one of that playbook is discretionary spend reductions.

Salesforce has had a layoff.

Maybe it's cutting back your number of Salesforce licenses.

It's things that don't affect your employee base, but do kind of streamline and make you more efficient right before a potential downturn.

I think those are getting pulled.

And the people who seem to get most affected in the tech world are people dependent on digital advertising, people dependent on license agreements being renewed.

I haven't yet seen that in the broad mass of the economy, right?

And so I just point that out, we're on page one of the playbook.

There are a few sectors that have moved down the pages, like the mortgage business, obviously.

But most businesses haven't turned the pages of that playbook yet, but they might.

You know, they might because we're raising rates.

They might because a whole sector tends to move in unison.

They might because their own businesses go south.

But again, I just say.

the thing that I hear time and time again as I'm talking to people is they're worried about the economy, but their own business, with the exceptions I've talked about, is actually still pretty healthy.

- They meaning some of these broad employers, are they more fearful of cost overruns, or uncontrollable costs?

Or are they more fearful of not having the talent?

As you talked about earlier, and we've also heard that on this program, that they're holding onto their workers so much that they're afraid to cut 'em loose.

Do you think that pendulum's starting to swing back to, well, costs may be a longer term issue for us?

- The dynamics of being a executive running a company have changed a lot, obviously, in the last few years.

And I'm not talking about just about hybrid and pandemics and everything else.

I'd just say for 20, 30 or 40 years, it just felt like you didn't have much scope to change your pricing, right?

That if you went into your retailer and you said, my labor costs are up, I've gotta get a price increase, the retailer would say, well I'm just gonna send this stuff to China.

So what do you want?

Do you want the business or do you want your price increase?

And I think what's happened over the last 18 months with the inflation we've had, is pricing has been validated as a lever that businesses can use.

And that means that as they look at their situation...

They all look at it differently.

Every sector has a different set of pressures.

They're looking at their margins and thinking about how to move the margins.

A great way to move margins is volume.

So to the extent they've got good sales volume, look at airlines, hotels, they're still very, very, very vibrant right now 'cause people are traveling, okay?

Or you move price, that's the second lever.

But if you don't think you've got volume, and you don't think you have price, then you think about cost.

And cost's the most painful, of course.

But it's also the most tangible and easiest to do so.

And a lot of these businesses have for 20 or 30 years worked on costs.

They know how to do that.

And within cost, there's been two pieces of it.

There's the non-headcount cost and the headcount cost.

The non-headcount cost is the discretionary spend, advertising, that's the stuff I'm talking about as the page one of the playbook.

The further pages of the playbook are when you go to start looking at headcount costs.

- You talked about recession.

And obviously, that's looming large for a lot of people.

Is it as binary as it used to be?

We're either in a recession or we're not in a recession.

I've heard economists call this a rolling recession.

I've heard a lot, a slow session, whatever the new term is, are we in a recession?

Will we be in a recession?

Does a recession mean what it used to mean the last business cycle?

- It's a great question.

The thing that even our generation has trouble remembering, is not every recession looks like 2008, 2009.

That was very much exacerbated by the challenges we had in the banking system, right?

That don't seem to have played out, and hopefully won't.

2001 was exacerbated by 9/11 and what came after that.

The pandemic obviously was a recession all its own.

I do think looking at some of the recessions back in the early parts of our career, '91-92 is a really useful one to think about because I was in business at that time.

And it absolutely felt like a rolling recession.

It hit this sector and then it hit that sector and then it hit that sector.

But by the time it hit the third sector, the first one was already coming out of it.

And we may have that.

Housing's a great example.

Housing boomed during COVID.

Price of houses up something like 45%.

It's had a very tough year.

But actually, if you look at some of the metrics on a historic basis, we've gone from explosive to back to where we normally are, things like housing starts.

And maybe we'll go south of that, maybe we won't.

But there'll be a recovery in that sector.

And that recovery may happen simultaneously with downturns in other sectors.

Historically, that's not an uncommon framework.

- Does housing have a new high watermark for pricing?

For construction as well as home prices?

- Well, we probably have to start at the beginning with housing, which is, coming out of the great recession, we underbuilt housing for 10 years as a economy.

And part of that was, it didn't look like that good of a business.

And part of that was the regulators and the banks tightened up some on the standards.

Some of that was that millennials didn't really wanna buy a house for 10 years, and they were living in whatever multi-family situation they were in.

Well COVID comes.

There's no better way to understand the flaws of your house than to live in it 24 hours a day.

There's also no better way to understand the flaws of your roommate than to live with him or her for 24 hours a day.

And so people went to buy houses and second houses.

People went from two people sharing an apartment to two people buying a place.

And so household formation is the technical term, it increased.

And then you couldn't get any supply of houses because part of it, the builders were shut down for a period of time.

But also older people, with COVID being a risk in nursing homes.

didn't wanna move out of their single family situation into a multi-family.

And so demand spiked, supply was constrained, prices went up.

And like I said, it differs by market, but in the mid-40s.

And that's the number one thing I hear when I'm around the Carolinas is people, especially workers, unable to find houses, I mean, at a price they can afford.

So now the Fed's increasing rates, as we need to.

The first sector that's hit is housing.

And that's obviously had an impact on housing demand.

It's actually probably had as much of an impact on housing supply.

People who have a 3%, 4% mortgage don't wanna sell their house and buy a house with a 7% mortgage.

Part of that is just, it's gonna take time to settle.

You know, you and I, our first houses, they weren't at 3% mortgages.

They were at seven or eight or nine or 10%.

- Which wasn't bad.

- Mortgage, which was how...

So it's not like a 7% mortgage by definition tubes the housing business.

But there is a transition there.

And there's a mindset transition.

And then we're gonna get to the other side, and people will say, I just took a new job.

I've gotta sell this house and buy a new one, or whatever version of that.

Those are things that are gonna happen.

And as supply opens up and demand comes back to normal levels, you're gonna see prices settle.

Not probably back to where they were before COVID, in part because some of this desire to be in a house that you really wanna be in as you work remotely, that's gonna persist.

And as that persists, that means the demand for housing is probably gonna be stronger than it was five or 10 years.

It'll still take some time for the builders to catch up.

Construction costs were elevated, still are elevated, in part because of the housing demand, but in large part because of all the demand for warehouses and distribution centers and now infrastructure being built.

So that'll take some time to settle as well.

- We've got about three minutes left.

And with all respect to you being a central banker, the end product, or the consumers see, fiscal policy and monetary policy.

And fiscal policy, of course, being controlled by a majority in the US House of Representatives, Republican Conservative.

And the debt ceiling debate that goes on, the statutory limit of the federal government to allow borrowing, as you know, looks like it may become a battle enjoined to the 11th hour.

And if we remember from 2012, that ended up going past the 11th hour, and caused some serious volatility and uncertainty within the US.

Would you predict that that could happen again?

What are your thoughts as Congress goes forward here?

- Well, the debt ceiling, is Congress, not our lane.

So I'm not gonna get into into that.

I do think, and I think most people think, it's pretty inconceivable that the US government would default on its debt.

- Okay, I would be remiss if I didn't ask you about interest rates.

And again, I know you have a limit within that.

Many talked about whatever that terminal rate is.

What would be a good terminal rate?

And what is a terminal rate?

- So most people define the terminal rate as how high will the Fed go in its efforts to take rates, in its efforts to combat inflation?

I don't think about it in terms of a terminal rate, other than a terminal rate of inflation.

I think the terminal rate of inflation is two 1/2%, I mean it's 2%, sorry.

- Yeah.

- 2%, terminal rate of inflation is 2%.

And that's our target, and that's where we're trying to go.

And at least speaking for myself, I'm focused on what rate does it take to get inflation down to 2%.

And I will learn about that as we go.

And that's what I'm doing right now.

I watch very carefully inflation.

If inflation comes back to target quicker, the terminal rate is gonna be lower.

If the inflation takes longer or further or more to get back to target, then the terminal rate would be higher.

- In 30 seconds, what do you watch specifically on inflation that's an important number for you?

- I'm looking very closely at the trimmed mean or median metrics of PCE inflation.

PCE inflation's our target.

Median tells you that on the vast majority of things that you and I are buying, inflation is back toward our target.

And in a world where many prices escalated hugely and are now coming back quickly, looking at the average, I think is distortive.

So I'm looking very closely at the median trimming measures of PCE inflation.

- Well articulated, thank you for being on our program.

Thanks for being a good luck charm for us too, 'cause we're back in the studio.

But thanks President Barkin.

- No, great to be here, and thanks as always Chris.

- Yeah, thank you sir.

Thank you for watching our program.

Until next week, I'm Chris William.

Certainly hope your business is good.

And almost spring and maybe a better economy.

Until next week, goodnight, thank you.

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